Tuesday, January 4, 2011

Opportunity Cost

Opportunity cost is a subject that has fascinated me for quite some time. Basil over at Gold Capped perked my ears to the concept in his Time is Money post, and my Torts professor helped me really grasp the concept. Simply put, opportunity cost is the money you're not making by doing something else. The best, and for me the most relevant, illustration is the opportunity cost of going to a graduate school like law school. I graduated from college and instead of getting a job and making money, I am now going to spend three more years shelling out obscene amounts of cash to another institution. The opportunity cost of going to law school is the money I could have made during these three years if I had got a job instead.

In WoW, opportunity cost comes up most frequently in the context of farmed materials. As Basil pointed out, farming isn't free. Farming in particular has two opportunity costs to watch out for. First, there is what you can earn from the different uses of those gathered mats. Second, there's the opportunity cost of farming itself.

Let's say you've just farmed up a bunch of Elementium Ore. You run to the auction house and see that the ore is selling for 5g each, but Elementium Bars are selling for 12g each. So do you smelt or sell the raw ore? Whichever you choose you'll still be making gold, but in this illustration the opportunity cost for selling raw ore is what you could have earned by smelting. In this case, you're missing out on 20g per stack of ore if you sell it raw. This is a very simple illustration, but where it gets more tempting to think "farming = free" is when you throw more steps into the process. Take, for example, the process of turning ore into enchanting materials. First you need to get the ore, then you need to prospect it, then you need to make the items, then you need to disenchant them. If you farmed all that ore yourself, it's fairly tempting to look at the end result of all the dust and essences and just go for it. But you could be losing out on a lot of gold this way. You need to check every step to see which is the most profitable. Can you get more selling the ore? Selling the raw gems? Selling the crafted items? If your goal is to get the most money out of your stuff, you should check to see if that's really what you are doing.

But what if your goal isn't profit, but self-sufficiency? What if you want to make a specific item for yourself, but don't want to buy it or the materials off of the AH? Does farming the mats make it free in this case? Unfortunately, probably not because of opportunity cost. Especially right now as people level their professions, a lot of stuff is being dumped in the AH for below what it costs to make. Enchanting scrolls and gems are where you see a lot of this. For example, let's say you're a JC and there's a gem cut you really want. You have a ton of rares left over from prospecting, so you're good to go. You spend 3 tokens, get your cut, gem your gear, and feel quite pleased that you didn't have to spend a single copper to do so. But don't celebrate yet - there might be a steep opportunity cost to what you just did. At the most basic level, the opportunity cost is going to be what you could have sold the raw gem for minus what you could have bought the cut gem for. If the cut gem is on the AH for 80g and the raw gem is selling for 100g, you just missed out on 20g per cut. The smart thing to do would have been to sell the raw gems and buy the cut ones. And then, of course, there's the opportunity cost of using your tokens to buy an unprofitable cut. By getting a cut you can't make gold from, you've missed out on getting a cut that can bring in gold!

There's also the opportunity cost of farming itself. Farming takes time. Time that could be spent doing other things. Like making gold more efficiently. I'll using mining v. prospecting, yet again, because it's my favorite. Say it takes an hour to farm 10 stacks of Obsidium ore (this might be high or low, I have no idea) and you can sell each stack for 70g. That's 700g for an hour's work, not bad. Now say each stack will prospect into 6 green gems that sell for 20g each, and it takes 3 minutes total to buy the ore, prospect and list the gems. That's a 50g profit per stack (6 gems/stack at 20g each minus 70g per stack) for a 500g profit total. For 3 minutes of work. Now obviously in this case farming is more profitable than prospecting in terms of sheer amount earned, but when you factor in the time cost prospecting is the clear winner. For three more minutes of work you can make another 500g. You've now made more than the farmer did in 1hr and you've saved yourself 54 minutes to go do whatever, WoW or non-WoW related. Of course, farming isn't always that bad. When studying for exams, I liked to farm while listening to recorded lectures. I also know people who enjoy watching TV while they farm. In cases like that, farming is actually an excellent way to make gold as you're effectively reducing the opportunity cost by making gold and doing that "something else." I was already going to listen to those lectures, might as well make some gold while I do it!

This leads me to my last point, which is don't get carried away thinking about opportunity cost. If you think about it too hard you'll quickly realize that everything you do that's not actively earning you gold is making you miss out on potential profits. Those two hours spent in a heroic were two hours you could have spent working with your professions to make gold. But on the other hand, those two hours spent working with your professions were two hours you could have been gearing up in heroics. Opportunity costs cuts both ways. Every time you're doing one thing you're not doing something else, so the important thing to do is to do the more important thing. Don't get so caught up in opportunity cost that you start stressing about all the gold you're not making. There are much more important things than making WoW gold, like sleeping.

"If you think about it too hard you'll quickly realize that everything you do that's not actively earning you gold is making you miss out on potential profits.....Every time you're doing one thing you're not doing something else, so the important thing to do is to do the more important thing."

I ran into this very psychological block just last night. For the first time ever I hesitated on joining a quasi-guild dungeon run because I was in the middle of prospecting and scanning the AH.

I then realized I need to straighten my [WoW time] priorities, or at least establish some sort of schedule/agenda/routine to make my WoW time more productive.

The best goblins out there don't camp the AH or spend hours farming, and I shouldn't either.